Fuel - More myth than fact?

Submitted: Wednesday, Jun 04, 2008 at 15:18
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One of the biggest, if not the biggest, myths in the fuel debate is that refiners of petroleum products are making a fortune because of the high price of fuel.

The fact is that refining petroleum products is a high volume, low margin and extremely competitive business. One of the reasons is that fuel is a highly commoditised product; you don’t care who makes it, or who sells it, because no-one company has a unique product. Fuel is fuel; consumers just want the cheapest price and are rarely loyal to any one particular brand.

This isn’t to be confused with the money being made out of pumping oil out of the ground; let’s face it the Saudi’s made a small fortune out of selling it to the world at US$20 per barrel, so at US$ 125 it is fair to say they are probably making a lot more. The same can be said for many other countries and companies engaged in this activity.

It is also fair to say that there are some companies that are fully integrated, pumping it out of the ground, and eventually refining it. However, if you look at the recent BP profit numbers you’ll see that globally they made very little from refining oil into petroleum products and in fact had expected to make a loss from this part of the business.

All refineries purchase crude oil at the going market rate for a barrel of oil and whilst there may be times that the margin received for refining into petroleum products is higher than at other times, if you look at it on a long-term basis the margins are nominal and confirm it is indeed a high volume, low margin business.

America, the bastion of global capitalism has not built one new refinery in 30 years. Take a look at the size of the consumer base and the economy of scale in that country and ask the question why this would be the case if there is so much money to be made out of refining oil into petroleum products – the answer is simple; the economics don’t stake up when you look at the capital cost versus the return.

The Port Stanvac refinery in South Australia closed in 2003 because the capital cost that Mobil faced to upgrade to meet new standards in 2006 did not stake up against the returns that could be generated. Whilst considerable upgrades have occurred in recent years to Australian refineries most were built in the 1950/60s; on average over 50 years ago. Again, I pose the question; if there is so much money to be made out of refining oil into petroleum products why we aren’t seeing investment in new refineries?

Most of the new refineries are being built in the high growth areas in Asia and the sub-continent, particularly China and India. These are large by Australian standards and have the efficiency inherent in new facilities and will have high throughput and economy of scale.

I’ve said before that the one of the greatest threats in Australia is not the price of refined petroleum products, but whether the refining companies can make a return sufficient enough to compete with imported products and one that enables on-going commitment to the Australian facilities.
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Reply By: Member - David P (VIC) - Wednesday, Jun 04, 2008 at 15:42

Wednesday, Jun 04, 2008 at 15:42
Agree, just check out the share price performance of Caltex, thats where you will find the truth.
With regard to continuing investment in existing refineries, that must be under increasing pressure with the potential move to coal/gas diesel and L/CNG further reducing ROE/ROI....fascinating times,
AnswerID: 307724

Reply By: Splits - Wednesday, Jun 04, 2008 at 16:34

Wednesday, Jun 04, 2008 at 16:34
I think I can remember reading something along these lines in a Woodside report years ago.

That same report also said our own reserves of oil are small, are located in areas that make them expensive to extract and are nowhere near enough to meet our future needs.

I may be wrong but didn't the reason Malcom Fraser brought us into line with world parity prices have something to do with making it worthwhile for the oil companies to either continue refining or exploring here?

Another thing that looks a bit scary is there is plenty of evidence that says the US has about 5% of the world's population and uses about 25 to 30% of the world's energy. I would say even us with our tiny population would use more energy than our pouplation percentage.

Based on the US ratio, China alone, never mind with India included, would be entitled to use 100% of the world's energy.

I wonder how much wil be left for us in the years ahead.

Brian

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Follow Up By: Member - Mfewster(SA) - Wednesday, Jun 04, 2008 at 18:28

Wednesday, Jun 04, 2008 at 18:28
I can only agree, except that I think it was Whitlam who initially moved on the oil parity policy because the 1974 fuel crisis created an economic crisis that blew his reforms to things like schools, free university fees. medibank etc right out of the water, destroyed his budgets and really kicked inflation along. We all forget what the Whitlam government was sacked for. Their other response to the same 1974 crisis, was to try to "fuel proof" Australia by building a network of gas pipes to connect the fields up north to the south. They were blocked from getting the money in the Senate by the Liberals and Nats and Rex Connors, the energy minister, then tried to raise the money by a dodgy deal in the middle east with Khemlaini. When details of this deal came to light, the grounds were opened to sacking them. What ever else one thinks about Whitlam's government, they had more energy and foresight than the total of all our governments since. If that pipeline had been built, our fuel situation would look very different today.
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Follow Up By: howesy - Wednesday, Jun 04, 2008 at 19:34

Wednesday, Jun 04, 2008 at 19:34
Yes there were many scandals in the Whitlam govt. including the loans affair and if allowed to continue governing they may well have been sacked who knows but the fact is they weren't sacked for any of those reasons and indeed weren't sacked at all.
They were removed as a result of a constitutional crisis caused by 2 parliamentarians dying in office and byelections replacing them with liberals giving the govt a minority. When The libs decided to block all bills put before them it created a constitutional crisis and a govt who could not effectively govern so the governor general used powers to disolve parliament.
It's all documented but as I said there were many blunders that maybe they should have been sacked for but in the same documents at also reveals that they had the highest record to date of new legislation passed and introduced more reforms than any other govt right up until today.
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Follow Up By: howesy - Wednesday, Jun 04, 2008 at 19:34

Wednesday, Jun 04, 2008 at 19:34
sorry of the topic but just thought it interesting
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Follow Up By: Member - Mfewster(SA) - Wednesday, Jun 04, 2008 at 20:37

Wednesday, Jun 04, 2008 at 20:37
Howesy, it was a fascinating period. As I recall. it wasn't a by- election that was responsible for the final nail, but Gough being too clever by half. He offered Vince Gair in the Senate the one thing Gair couldn't refuse -a diplomatic post in Ireland. Gair took it but Bjelke Peterson broke the repacement convention and Gair was replaced by a Petrson nominated patsy who would block supply. The Khemlaini affair was the reason given for blocking supply because the Whitlam government had gone outside the Loans Council to get the $. Still wish that pipeline had been built.
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Reply By: Member - Oldplodder (QLD) - Wednesday, Jun 04, 2008 at 16:39

Wednesday, Jun 04, 2008 at 16:39
Good post, valid points.

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Reply By: DIO - Wednesday, Jun 04, 2008 at 18:41

Wednesday, Jun 04, 2008 at 18:41
Australia is a very (VERY) small player on the world scene regarding oil production and fuel consumption. We are at the mercy of world markets. If you were a shareholder of Caltex, Mobil, Shell etc and they weren't paying you a dividend because they didn't make a profit, what would your reaction be?

High prices (with HIGHER on the way) are here to stay for some time yet. When the transport industry, taxi industry and 'joe everage' motorist assemble en-masse outside Parliament House Canberra and demand change of policy or change of Govt. something 'might' happen - though don't hold your breath.
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Follow Up By: Member - Alan H (QLD) - Wednesday, Jun 04, 2008 at 19:56

Wednesday, Jun 04, 2008 at 19:56
From economic terms, fuel is an inelastic supply and supplied by a monopoly (welll four). If fuel went down to $1 a litre we would not buy more and just spill it on the ground just because it cost less. We buy the amount of fuel that we require. No more no less. - so there is no real supply and demand equation at work.

Because fuel is so inculcated into our society and with few alternatives (they are discouraged) we have to buy what ever the price and go without something else. We have been conditioned to higher prices and the oil companies can put prices as high as public outcry allows as we have no power to prevent it.

We can't stop buying fuel and price will rise (because it can and the supply) until greed levels get that high that alternative fuel does appear. Alternative fuel can then just take over the price regardless of cost because that will be what the market is used to paying for fuel.

Rave over - sorry
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Follow Up By: Mike Harding - Wednesday, Jun 04, 2008 at 20:23

Wednesday, Jun 04, 2008 at 20:23
>From economic terms, fuel is an inelastic supply and supplied by a
>monopoly (welll four). If fuel went down to $1 a litre we would not
> buy more and just spill it on the ground just because it cost less.
>We buy the amount of fuel that we require. No more no less. - so
>there is no real supply and demand equation at work.

Not true.

Put petrol up to $5 (choose your number) per litre and see how many people go for Sunday drives.

Mike Harding
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Follow Up By: wigger - Wednesday, Jun 04, 2008 at 20:37

Wednesday, Jun 04, 2008 at 20:37
Alan, I don't agree with you that petrol is inelastic . If the price goes down we do in fact buy more. I fly to Sydney at the moment because of the incresed price of fuel. If the price went down I'd drive and buy more. It's element of inelasticity is in downward movement. Most of us can not drop much beneath our current usage figure, assuming we are not all on holiday travel.
Bread is a better example of inelasticity. If cheaper, would we eat much more. No.
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Follow Up By: The Landy - Wednesday, Jun 04, 2008 at 20:46

Wednesday, Jun 04, 2008 at 20:46
Alan

When you speak of oil companies do you mean the companies who pump it out of the ground, or the companies that refine oil into petroleum products? The two are often spoken of as one group and this often confuses the discussion on fuel pricing and is the main thrust of my point here.

Refining companies buy oil at the market price and refine it into petroleum products in what is a highly competitive and very marginal business. Oil companies pump it out of the ground and whilst some have integrated businesses, many don't.

The 'market' determines what it is willing to pay for a barrel of oil not the oil companies. A free market exists where oil for immediate and future delivery is determined by a myriad of participants in an actively traded futures market. We could argue that the speculators who have been largely responsible for the recent spike higher in oil prices are driven by greed, however they play a role in making markets more efficient by providing liquidity and taking price risk.

Finally, I believe there is a supply and demand equation at work. A number of Asian and sub-continent countries are presently reviewing the subsidies they provide to the cost of fuel. Many, including India, Malaysia and Indonesia subsidise fuel costs. Consequently, consumers in these economies have had no need to modify their fuel usage because they have not been exposed to higher fuel prices. This is currently changing and there will be a number of developments over the coming weeks that will see a lot of these subsidies removed or in the least reduced. This will, in turn, see reduced demand as the increased price in these countries affect consumers.

We've seen this in Australia; higher fuel prices have lead to an increase in the use of public transport for instance.

Regards
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Reply By: Bware (Tweed Valley) - Wednesday, Jun 04, 2008 at 22:43

Wednesday, Jun 04, 2008 at 22:43
Hi Landy,

I have learnt much from your posts/replies/follow-ups on this subject. I appreciate the research and effort you have contributed.

I have at times taken you to task about fuel pricing out of a desire to understand. But now I would just like to raise some points that I find interesting.

I believe a major problem is the view the general public has of the fuel industry. The general public believes that the fuel companies are crooks. All they know is (whether true or not) that prices go up when it’s school hols, Easter, Xmas etc and that they put the prices up before the weekend.

People compare fuel to other necessities like bread and milk and find that they don’t vary in price between suburbs unless it is a small shop or a remote area. Hence the frustration with individual fuel outlets and their pricing.

This has been going on for years. You would think that some good public relations would be in order but it doesn’t happen. Why have they never explained to the public that when the prices are up that this is the normal price and when they are down it is the discounted price? They only have themselves to blame for the public attitude. I can only come to the conclusion that they don’t care about their image. For what reason I do not know. By your reasoning it can’t be because they are making huge profits and therefore don’t need to worry about it.

Their standout advertisements that I can recall are things from the ‘70’s like “go well, go shell” and now we have discount vouchers if you shop at certain chain-stores. That’s about it for P.R.

Some folk have mentioned that fuel pricing is within the perimeters of if you look at the average wage 20 years ago and the price of fuel 20 years ago etc. I think that is a bit simplistic. I know that diesel was less than 70cents a litre when I left Sydney 10 years ago. It has more than doubled. Other living costs have changed dramatically as well; power, phone, water, land rates, groceries, rent or mortgage, etc. I’m pretty sure my wage hasn’t matched all those increases.

People may be taking out their financial frustration on the fuel companies. After all it is only a few cents a litre. But if we compare it to the public understanding of milk, for instance, we know that the farmer is getting bugger all and therefore I am willing to buy Norco and pay the extra few cents than support Coles with their cheaper product. Why? Because I know about it. I have been educated by the people concerned

Regards

Brian.

AnswerID: 307810

Follow Up By: The Landy - Thursday, Jun 05, 2008 at 10:30

Thursday, Jun 05, 2008 at 10:30
Hi Brian

Appreciate your comments and nothing wrong with taking someone to task, especially when it leads to informed discussion!

Your comment is correct that the fuel industry has a poor public image despite concerted efforts by their peak body to correct this. The perception that they make huge profits and are gouging the public is often perpetuated in the popular media, especially the talk-back radio set and why not, it makes for keeping the likes of Alan Jones and others popular. Rarely does it provide a balanced view and unfortunately is the source of many untruths and myths that become perpetuated in forums like this.

One of the main problems, as I have highlighted in this recent comment, is that people are frequently confusing who they are actually talking about in the fuel debate. There are very distinct players, oil producers who pump it out of the ground and refiners who convert oil into petroleum products.

Regards
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